Fiscal Policy Refers To The Use of Government Spending and Tax Policies To

AE12 – FISCAL POLICY
What Is Fiscal Policy?
Fiscal policy refers to the use of government spending and tax policies to
influence economic conditions, especially macroeconomic conditions,
including aggregate demand for goods and services, employment, inflation, and
economic growth.
Fiscal policy is often contrasted with monetary policy, which is enacted by

central bankers and not elected government officials.
Understanding Fiscal Policy
Fiscal policy is largely based on the ideas of British economist John Maynard

Keynes (1883-1946), who argued that economic recessions are due to a
deficiency in the consumer spending and business investment components of
aggregate demand. Keynes believed that governments could stabilize
the business cycle and regulate economic output by adjusting spending and tax
policies to make up for the shortfalls of the private sector.
His theories were developed in response to the Great Depression, which defied
classical economics' assumptions that economic swings were self-correcting.
Keynes' ideas were highly influential and led to the New Deal in the U.S.,
which involved massive spending on public works projects and social welfare
programs.
In Keynesian economics, aggregate demand or spending is what drives the

performance and growth of the economy. Aggregate demand is made up of
consumer spending, business investment spending, net government spending,
and net exports. According to Keynesian economists, the private-sector
components of aggregate demand are too variable and too dependent on
psychological and emotional factors to maintain sustained growth in the
economy.
Special Considerations
Pessimism, fear, and uncertainty among consumers and businesses can lead to
economic recessions and depressions, and excessive exuberance during good
times can lead to an overheated economy and inflation. However, according to
Keynesians, government taxation and spending can be managed rationally and
used to counteract the excesses and deficiencies of private-sector consumption
and investment spending in order to stabilize the economy.
When private-sector spending turns down, the government can spend more
and/or tax less in order to directly increase aggregate demand.
When the private sector is overly optimistic and spends too much, too fast on
consumption and new investment projects, the government can spend less
and/or tax more in order to decrease aggregate demand.
This means that to help stabilize the economy, the government should run
large budget deficits during economic downturns and run budget surpluses
when the economy is growing. These are known
as expansionary or contractionary fiscal policies, respectively.
Expansionary Policies
To illustrate how the government can use fiscal policy to affect the economy,
consider an economy that's experiencing a recession. The government might
issue tax stimulus rebates to increase aggregate demand and fuel economic
growth.
The logic behind this approach is that when people pay lower taxes, they have
more money to spend or invest, which fuels higher demand. That demand leads
firms to hire more, decreasing unemployment, and causing fierce competition
for labor. In turn, this serves to raise wages and provide consumers with more
income to spend and invest. It's a virtuous cycle. or positive feedback loop.
Rather than lowering taxes, the government may seek economic expansion
through increases in spending (without corresponding tax increases). Building
more highways, for example, could increase employment, pushing up demand
and growth.
Expansionary fiscal policy is usually characterized by deficit spending, when

government expenditures exceed receipts from taxes and other sources. In
practice, deficit spending tends to result from a combination of tax cuts and
higher spending.
The Downsides to Expansion
Mounting deficits are among the complaints lodged about expansionary fiscal
policy, with critics complaining that a flood of government red ink can weigh
on growth and eventually create the need for damaging austerity. Many
economists simply dispute the effectiveness of expansionary fiscal policies,
arguing that government spending too easily crowds out investment by the
private sector.
Expansionary policy is also popular—to a dangerous degree, say some
economists. Fiscal stimulus is politically difficult to reverse. Whether it has the
desired macroeconomic effects or not, voters like low taxes and public
spending. Due to the political incentives faced by policymakers, there tends to
be a consistent bias toward engaging in more-or-less constant deficit spending
that can be in part rationalized as “good for the economy”.
Eventually, economic expansion can get out of hand—rising wages lead to

inflation and asset bubbles begin to form. High inflation and the risk of
widespread defaults when debt bubbles burst can badly damage the economy
and this risk, in turn, leads governments (or their central banks) to reverse
course and attempt to "contract" the economy.
Contractionary Policies
In the face of mounting inflation and other expansionary symptoms, a

government can pursue contractionary fiscal policy, perhaps even to the extent
of inducing a brief recession in order to restore balance to the economic cycle.
The government does this by increasing taxes, reducing public spending, and
cutting public-sector pay or jobs.
Where expansionary fiscal policy involves deficits, contractionary fiscal policy

is characterized by budget surpluses. This policy is rarely used, however, as it
is hugely unpopular politically. Public policymakers thus face a major
asymmetry in their incentives to engage in expansionary or contractionary
fiscal policy. Instead, the preferred tool for reining in unsustainable growth
is usually a contractionary monetary policy, or raising interest rates and
restraining the supply of money and credit in order to rein in inflation.
Who Handles Fiscal Policy?
Fiscal policy is enacted by a government. This is opposed to monetary policy,

which is enacted through central banks or another monetary authority. In the
United States, fiscal policy is directed by both the executive and legislative
branches. In the executive branch, the two most influential offices in this regard
belong to the President and the Secretary of the Treasury, although
contemporary presidents often rely on a council of economic advisers as well.
In the legislative branch, the U.S. Congress authorizes taxes, passes laws, and
appropriations spending for any fiscal policy measures through its "power of
the purse". This process involves participation, deliberation, and approval from
both the House of Representatives and the Senate.
What Are the Main Tools of Fiscal Policy?
Fiscal policy tools are used by governments that influence the economy. These
primarily include changes to levels of taxation and government spending. To
stimulate growth, taxes are lowered and spending is increased, often involving
borrowing through issuing government debt. To put the dampers on an
overheating economy, the opposite measures would be taken.
How Does Fiscal Policy Affect People?
The effects of any fiscal policy are not often the same for everyone. Depending
on the political orientations and goals of the policymakers, a tax cut could
affect only the middle class, which is typically the largest economic group. In
times of economic decline and rising taxation, it is this same group that may
have to pay more taxes than the wealthier upper class. Similarly, when a
government decides to adjust its spending, its policy may affect only a specific
group of people. A decision to build a new bridge, for example, will give work
and more income to hundreds of construction workers. A decision to spend
money on building a new space shuttle, on the other hand, benefits only a
small, specialized pool of experts and firms, which would not do much to
increase aggregate employment levels.
Should the Government Be Getting Involved with the Economy?
One of the biggest obstacles facing policymakers is deciding how much direct
involvement the government should have in the economy and individuals'
economic lives. Indeed, there have been various degrees of interference by the
government over the history of the United States. But for the most part, it is
accepted that a certain degree of government involvement is necessary to
sustain a vibrant economy, on which the economic well-being of the population
depends.
Activity. True or False (10 points each)

1. Fiscal policy refers to the use of government spending and tax policies to
influence economic conditions, especially macroeconomic conditions,
including aggregate demand for goods and services only.
2. Fiscal policy is largely based on the ideas of British economist John
Maynard Keynes, who argued that economic recessions are due to a deficiency
in the consumer spending and business investment components of aggregate
demand.
3. Keynes believed that governments could stabilize the business cycle and
regulate economic output by adjusting spending and tax policies to make up for
the shortfalls of the private sector.
4. According to Keynes, aggregate demand is made up of consumer spending,
business investment spending, net government spending, and net imports
5. Pessimism, fear, and uncertainty among consumers and businesses can lead
to economic recessions and depressions, and excessive exuberance during good
times can lead to an overheated economy and inflation.
6. Contractional policy is usually characterized by deficit spending, when
government expenditures exceed receipts from taxes and other sources.
7. Where expansionary fiscal policy involves deficits, expansionary fiscal
policy is characterized by budget surpluses.
8. Fiscal policy is enacted by a government.
9. Fiscal policy tools are used by governments that influence the economy and
primarily include changes to levels of taxation and government spending.
10. The effects of any fiscal policy are not often the same for everyone,
depending on the political orientations and goals of the policymakers, a tax cut
could not affect the middle class, which is typically the largest economic
group.
REFERENCE:
https://www.investopedia.com/terms/f/fiscalpolicy.asp

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AE12 – FISCAL POLICY

What Is Fiscal Policy?

Fiscal policy is often contrasted with monetary policy, which is enacted by

Understanding Fiscal Policy

Fiscal policy is largely based on the ideas of British economist John Maynard

In Keynesian economics, aggregate demand or spending is what drives the

Expansionary fiscal policy is usually characterized by deficit spending, when

The Downsides to Expansion

Eventually, economic expansion can get out of hand—rising wages lead to

In the face of mounting inflation and other expansionary symptoms, a

Where expansionary fiscal policy involves deficits, contractionary fiscal policy

Who Handles Fiscal Policy?

Fiscal policy is enacted by a government. This is opposed to monetary policy,

What Are the Main Tools of Fiscal Policy?

How Does Fiscal Policy Affect People?

Should the Government Be Getting Involved with the Economy?

Activity. True or False (10 points each)

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